Bankruptcy for Business Debt: 7 Obligations a Filing May Not Erase

A discharge is narrower than its reputation. It releases a debtor from personal liability on the debts it covers, and it does nothing to the property that secures them, nothing to the other people who promised to pay them, and nothing at all for a company that files Chapter 7.

Seven kinds of obligation tend to outlast a filing, in whole or in part. Some of them survive because of who the debtor is, and some because of what the debt is.

1. A Lien Can Be Resized in a Plan, but the Discharge Alone Leaves It in Place

Bankruptcy measures a secured claim against the collateral. Under Section 506(a), a claim is secured "to the extent of the value" of the creditor's interest in the property and unsecured for the balance. Take a hypothetical equipment lender owed $180,000 on machines worth $110,000: the claim divides into a $110,000 secured claim and a $70,000 unsecured one.

A Chapter 11 plan can work with that division. Section 1129(b)(2)(A) allows a plan to be confirmed over a secured class's objection if the creditor keeps its lien and receives deferred cash payments with a present value at least equal to the collateral, or the proceeds of a sale, or the "indubitable equivalent" of its claim. Section 1141(c) then leaves property dealt with by the plan free of other claims, except as the plan and the confirmation order provide.

The lien is, to put it precisely, reshaped by a plan and not removed by a discharge. Without a plan, as in a Chapter 7 case, the lien passes through the case. The Supreme Court held in Johnson v. Home State Bank (1991) that a discharge ends the creditor's personal action against the debtor while its right to proceed against the property survives, which is why a secured lender whose borrower was discharged may still foreclose.

For a business, the practical question is which assets carry liens and what they are worth, because that value is the floor any secured creditor can insist on.

2. Withheld Taxes Acquire a Second Debtor

Payroll taxes the company withheld from wages and did not pay over are a priority claim in the company's case under Section 507(a)(8)(C). The same money can be assessed against the individuals responsible for paying it, as a penalty under 26 U.S.C. 6672, and an individual who later files is not discharged from it, under Section 523(a)(1)(A). The company's case does not end the individual's exposure.

The penalty reaches the withheld portion only. The employer's own matching share remains a debt of the company, handled in its case with its other tax claims.

3. The Guaranty Sits Outside the Case

A guarantor's obligation is its own contract. Section 524(e) states that discharging a debtor's debt does not affect "the liability of any other entity on" it, and the automatic stay protects the debtor, not a nondebtor co-obligor, absent a court order. An owner who signed a guaranty should treat it as an obligation the company's filing will not reach.

4. A Fraud Claim Can Carve a Debt Out of an Individual's Discharge

For an individual debtor, Section 523(a)(2) excepts from discharge debts for money or credit obtained by "false pretenses, a false representation, or actual fraud," and, under subparagraph (B), debts obtained by a written statement about the debtor's financial condition that was materially false, reasonably relied on by the creditor, and made with intent to deceive. For an owner who signed financing applications and personal financial statements, subparagraph (B) is the one to read closely.

These exceptions do not operate on their own. Section 523(c) provides that debts of this kind are discharged unless the creditor asks and the court, after notice and a hearing, finds that the exception applies. The creditor has to sue, in an adversary proceeding, and prove its case.

Sixty days after the first date set for the meeting of creditors, the window for that suit closes. Bankruptcy Rule 4007(c) sets that deadline for complaints under Section 523(c) and permits an extension only on a motion filed before the time runs out.

A discharge is a presumption with a deadline attached. The creditor who misses the deadline has lost the argument without making it.

What the discharge offers, then, is a default that a creditor must work to overcome. A funder's letter calling an application fraudulent is not a determination of anything. There are defenses to these complaints, reasonable reliance among the first of them, though the list is better reviewed with the lawyer who would argue it.

Corporations are treated differently. For a corporation confirming a Chapter 11 plan, Section 1141(d)(6) withholds the discharge from certain fraud debts owed to a governmental unit or to claimants under false claims laws, and from taxes on which the company filed a fraudulent return or willfully evaded payment.

5. An LLC in Chapter 7 Leaves Its Debts Unpaid, Not Discharged

Section 727(a)(1) grants a Chapter 7 discharge only to individuals. When an LLC or corporation liquidates in Chapter 7, the trustee sells what it can and distributes the proceeds, and whatever remains unpaid is still owed, in law, by an entity that now owns nothing and no longer operates. Section 1141(d)(3) produces the same result in a Chapter 11 case that liquidates substantially all the property of a company that then stops doing business.

The debt is not erased. It is orphaned. That matters because creditors of an orphaned debt look for anyone else who is liable on it, which returns the question to the guaranty in the section above and to any transfers the owner received before the filing.

The company stops, the debt stays, and the people who signed for it are the ones who hear about it next.

6. Support Obligations Follow an Owner Into Any Personal Case

An owner who files personally to deal with business debt carries domestic obligations into that case unchanged. Section 523(a)(5) excepts from an individual's discharge any debt "for a domestic support obligation." It has nothing to do with the business. It still limits what a personal filing can accomplish for the household.

Support arrears also sit beyond the reach of any business settlement, since the party owed is a former spouse, a child, or a state agency, and none of them is negotiating over a merchant cash advance.

7. Government Fines Survive for Individuals and Stand Last in a Company's Liquidation

Section 523(a)(7) excepts from an individual's discharge a fine, penalty, or forfeiture "payable to and for the benefit of a governmental unit" that is not compensation for actual pecuniary loss, with some carve-outs for tax penalties. A licensing penalty or a regulatory fine assessed against a sole proprietor can fall into that description.

In a company's Chapter 7 case the same kind of claim is paid, if at all, fourth under Section 726(a)(4), after priority claims and after general unsecured claims. When the estate is insolvent, nothing is left by then. The fine survives in law and goes unpaid in fact.

What Settlement Can and Cannot Reach

An owner facing a dischargeability complaint, a trust fund assessment, or a lender preparing to enforce a lien needs a bankruptcy or tax attorney before anyone else. A settlement company is the wrong call for any of those.

Where the pressing obligations are merchant cash advances and unsecured term debt, and none of them carries a fraud allegation or a tax assessment, a negotiated settlement may resolve what a filing would leave in place, including the guaranties behind them. Delancey Street handles that kind of negotiation. Because it is not a law firm, it cannot advise on dischargeability or defend an adversary proceeding, and it brings in outside licensed counsel when the work turns legal. Its initial review is confidential and carries no charge.

A bankruptcy sorts obligations by their history: how they were incurred, who promised to pay them, what property stands behind them. An owner who knows that history before choosing a path has already done most of the analysis a court would do.